3SOF

  Obrigado David or should I say...(eheh, never mind).

David,

I just read all of the posts on shorting for the first time.

I am strongly in support of shorting in falling markets. Buying the dips in rising markets and selling the peaks in falling markets is trading 101.

Nevertheless we are not in a falling market right now but rather a sideways market. The expected return on the S&P 500 for 2006 is 1% plus a 2% dividend for a total return of 3% (There is a large potential standard deviation on that number!!!).

Shorting the S&P 500 now is cheap insurance on a portfolio. If the market takes off and the S&P 500 rises 10% for a 12% total return I will likely make far more than the 12% shorting loss by following your trading plan.

If the market continues as it has for the last year going sideways my hedge will cost me about 3% and I will likely make a lot of money from your portfolio.

If the market starts dropping I will make money on the short and you will likely have us all in cash or going short.

Once the time is right for shorting individual names we might want to look first at companies with negative earnings. If a company cannot make money in an expanding economy how will it make money in a contracting economy. A company with negative earnings has to have an extremely strong business case for it to continue rising in a falling market.

Second we may want to look at companies with junk bond debt ratings. I read yesterday that 2 out of 3 industrial companies on the S&P 500 have junk bond ratings. In a recession most of these companies will get hammered. (Spreads between junk bonds and treasuries are still relatively tight. As soon as spreads start blowing out it might be a good time to short industrials.)

Third there is always P/E compression in falling markets. Therefore shorting high P/E companies that do not have a strong business case is another thing to look at.

Fourth looking at sub indexes that are falling is another way to identify shorting opportunities. Specifically short companies in the sector that are not leaders in the sector  (the weaker companies). Go with the trend. (Note that it is obviously useful to understand the fundamental reasons for the fall in the sub index. Just as theme investing on the long side can be very profitable, so also theme investing on the short side can be as well.)

Fifth companies with contentious issues such as accounting problems, SEC investigations, senior management quitting without any explanation, litigation problems etc. produce good short candidates. (Another contentious issue in my opinion is senior managers getting high levels of fixed compensation relative to the size of the company.)

Sixth in the past I have looked at the returns of dedicated short managers and usually their returns are negative or flat at best except when a recession comes. It is evident that shorting all the time does not make money for most although it can be justified as a source of portfolio insurance. Short bias managers are starting to make a small amount of money now and I expect that will accelerate in the not too distant future. There is money to be made now through shorting specific names but it is primarily being made by those with strong skills in fundamental analysis. Once markets start trending down fundamental analysis becomes less important (although still important for maximizing profits) as the technical trend followers start shorting to go with the trend.

Seventh if we are going to start shorting names immediately we might want to have a "go to" list. As soon as the outlook is negative we would have an immediate list of companies we could access to short. This would likely be a list of high beta stocks that have shown a propensity to fall rapidly and materially when the indexes fall. The list would also have relative stop loss instructions for each name (for example, get out if you have a five percent loss or alternatively cover if the position breaks the upper limit of its volatility range for the last five days). Perhaps we could have a board where members can start suggesting short candidates backed by both technical and fundamental analysis. Included in the fundamental analysis would include both company specific issues and also themes and trends.

I am sure you are aware of the above but it might be a help to some investors less familiar with shorting.

QuoteI thought of going back to full invested again, but I feel that for just 1.5% of potential upside (according to my personal view, which can be wrong - I'll justify later) it's not worth it. What I'll do is to prepare myself for the next big move, which I think will be down, not up.
1285 points on the SPX, or 128.5 on the SPY, is the stop and reverse point. If we reach that point I will sell some longs and go predominantly short, even for the 3 SOF Fast Portfolio (specially in this).

Good luck and enjoy the bull ride, while it lasts 

David,

I also think shorting stock is a good idea. It's getting so hard to find a good picks in a bearish market and it's about time we see 3SOF Short . As most of us agree from the poll above we're here to make money.
More opportunities........better chances............of success (or failure) 

Bulls make money........ Bears make money

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BTW  I see some of the members are shorting stock and it would be better if all the picks and comments are in one place. IMHO..... 



Good luck.

Here is the Value Line index to show the typical 4-year cycle highs that usually happen in the first quarter of each 4th year. So the market may top in Jan to March and when that happens then shorts would be the way to go. The markets then usually make the 4-year low in that same year in the last quarter..

http://tinyurl.com/dmkl9

Right now the market of course is killer with most things just keep going up. The SOX broke out last week so that is very bullish and expect a nice year end rally that may last into Feb or March as most think it will end in January like last year.

There are short to be had at any time but it is best to not fight the general market trend which now is strongly up and as fund managers want to hit the best numbers they are likely to keep buying into the end of the year at least and then new money comes in in January

Hi david,
Do NOT consider short positions at this time!  It will result in probable disaster!
Right now, Program trading is 'in control' of the markets, this planned drop in stocks today & tomorrow is to rebalance the markets.  Then we lift off to reach Dow 12,000 before years end.

Do NOT get whipsawed out of long positions in stocks.  They're going much-much higher, IMO!  Next year too!

all JMHO...

willey

I haven't set up a short trade account (more paperwork) with Scottrade yet, though I'm tempted to bite the bullet and put it through.

Just saw an excellent short candidate based on David's success with SPEX - check this news:

Spherix's Toothy Smile

By Matthew Goldstein
Senior Writer
12/9/2005 4:13 PM EST
Click here for more stories by Matthew Goldstein

Updated from 11:09 a.m. EST
Spherix (SPEX:Nasdaq - commentary - research - Cramer's Take), the sugar-substitute maker whose stock has more than tripled this week on prolific volume, has a few cavities.

For one thing, the Maryland company bills itself as a science concern, but just about all of its $22 million in annual revenue comes from a tourist-reservation business it manages for state and national parks. It's a niche business that Spherix has managed to achieve some success in.

Selling tickets to see Old Faithful is not what got investors excited about Spherix, however. It's the company's long-held dream of finding a way to cash in on a low-calorie sugar alternative called Tagatose that's got investors frothing.

So far, Spherix has found few takers for its sugar substitute, which it has been trying to market for the past nine years under the brand name Naturlose.

Arla Foods, a Dutch company with the exclusive license to manufacture and sell Naturlose, has not generated any meaningful royalties from sales to food and beverage companies. Spherix also has made little from its attempt to market the milk byproduct as a sweetener for use in toothpaste, mouthwash and over-the-counter drugs.

There seems to be little demand for Naturlose as a food additive given the growing popularity of Johnson & Johnson's (JNJ:NYSE - commentary - research - Cramer's Take) low-calorie sugar product Splenda.

But hope springs eternal at Spherix, which believes it's on the way to getting Naturlose approved by the Food and Drug Administration as a drug to treat Type 2 diabetes.

On Dec. 6, Spherix issued a press release saying the FDA had "cleared the way" for the company to begin the final phase of clinical tests on Naturlose before seeking approval from the agency to sell it as a diabetes treatment. The company said the FDA gave the green light to begin the clinical trials following a meeting last month with several of Spherix's scientists.

The FDA, as a policy, doesn't comment on clinical trials before a drug is approved for market.

Nevertheless, the press release gave a sugar rush to Spherix's shares, sparking some frenzied trading in the normally sleepy stock with just 12 million shares outstanding. A day after the FDA announcement, more than 13 million shares of Spherix changed hands. On a good day, 50,000 shares of Spherix might be traded.

More significantly, Spherix share price took off like a rocket, rising from $1.27 a share on Monday to close at just under $5 a share on Wednesday. It fell back to $4.49 Thursday and slid again Friday, losing $1.04, or 23%, to $3.42.

Investors who binged on Spherix shares may have set themselves up for a sugar crash.

The company has lost money in each of the past three years and remains a long way from getting FDA approval for use of Naturlose as a drug. Indeed, the initial clinical trials using Naturlose as a diabetes treatment were "small" studies conducted by the University of Maryland about five years ago, Spherix said.

The early clinical trials, according to a company Web site, found that tagatose did not lead to any changes in subjects' glucose and insulin levels, and also helped with weight loss. The study concluded that tagatose, the product's scientific name, could be useful as a treatment of diabetes in conjunction with other drugs.

Of course, there's no guarantee the clinical trial will succeed when it's expanded to a much larger sampling of the population. Even Spherix acknowledges the company is a long way from getting FDA approval.

"The big hurdle is phase III," says Gilbert Levin, Spherix's chairman and chief science officer, who founded the company 38 years ago. "But getting there is no easy matter."

On Friday, a day after Levin talked to TheStreet.com, Spherix disclosed that the company's patriarch sold 62,900 shares on Dec. 7 and Dec. 8, after the announcement about the FDA meeting. The shares were sold at prices ranging from $4.60 to $4.75 a share, generating proceeds of about $289,000. After the stock sales, Levin reported owning 1.16 million shares.

So far, Levin, who owns 10% of the company's shares, is the only Spherix insider to cash in on the surge in the company' stock. Corporate insiders own about 21% of the company's shares. The other big inside shareholder is Levin's wife, Karen, who also has 10% equity interest. His wife is a director and vice president.

Levin, 80, is a big believer in Naturlose and its potential medical miracle. In 1995, when he was the company's chief executive and president, Spherix patented Tagatose as a treatment for Type 2 diabetes.

If nothing else, Levin, who turned over day-to-day control of the company earlier this year to his nephew Richard, is persistent.

To this day, he insists that an experiment he designed for use on the Viking space probe mission to Mars found signs of life on the red planet. NASA officials reject that claim, saying there was a problem with the results sent back by the unmanned spacecraft in 1976.

Levin, however, remains unmoved and believes his Mars experiment eventually will be vindicated. He says the same will happen one day with Naturlose.

"No major discovery was ever received favorably by peer review when it was made and that goes for Galileo and everyone forward," says Levin. "I'm sure it's going to be a very widely used product."

Earlier this year, Spherix suffered a setback in a clinical trial studying another potential medical use of Naturlose. Trials at the University of Maryland School of Dentistry didn't find any benefit from Naturlose in fighting the formation of plaque on teeth. The university's findings were "contrary to earlier laboratory findings by Spherix," according to the company's filings.

Investors also should bear in mind that Spherix, unlike most biotech companies that spend heavily on research and development, is a bit of a tightwad. The company reports spending just over $1 million on R&D over the past three years.

While Spherix waits for the results of the planned clinical trials, it may find itself hard-up for cash.

The company says it's facing the imminent loss of its contract to provide tourist reservation services for the National Park Service. Earlier this year, the Park Service awarded the contract, which accounts for 17% of the company's revenue, to a competitor. Spherix is protesting the decision, but says it cannot predict the outcome.

In an attempt to raise some badly needed funds, Spherix this summer turned to Cornell Capital Partners, a Jersey City, N.J., hedge fund. Over the next two years, Cornell is investing up to $4 million into the company through a financing vehicle known as a PIPE -- shorthand for private investment in public equity.

Last week, TheStreet.com reported that Cornell Capital is being investigated by securities regulators for its trading activity in shares of nine companies that it allegedly provided financing to. There's no indication that regulators are looking into the Spherix deal.

In many respects, the PIPE deal makes sense for Spherix because it provides it with a regular source of cash and because the company has few places to turn for financing. The deal is also good for Cornell because it gets to buy 2.38 million shares at a discount to their market value and can then quickly resell them.

But the flood of new stock is bad for current stockholders. In a filing discussing the deal, Spherix says its "common stock price may decrease due to the additional shares in the market."


So what we have is a Company that's main source of revenue is providing reservations for the parks dept. (and is losing that contract) that has invented a new Nutrasweet and has issued a misleading press release (Hello HYRF  ) implying it's a possible Diabetes treatment, while the whacko former CEO unloads stock during the run up.

This thing will continue falling like a rock, IMO, back below $ 1.00

Quote from: KCScott on December 10, 2005, 11:35:53 AM
Just saw an excellent short candidate based on David's success with SPEX.
......................................................................................................
This thing will continue falling like a rock, IMO, back below $ 1.00

KCScott,

I also believe that SPEX will go down as quickly as it rose up. We have seen that kind of movement many times but unfortunately Scottrade have some restrictions about shorting and one of them is they don't allow shorting a stock bellow $5.

Given David's message today, I have opened a margin account with Scottrade to begin shorting.

Jimbo, you were correct - You can't short any stocks under $5.00

As for selecting prime candidates for shorting, I recall from a recent episode of Mad Money, Cramer described several conditions that would cause him to sell ahead of the herd:

Competition - ie; Music retailers losing business to digital media
Accounting problems - restatement of earnings
Over expansion - Integration problems with acquistions / building too many stores
Government Interference - Regulation

Most downgrades occur, obviously, after the "train has left the tracks"

I also like the idea of using personal experience as a basis.

I can think of several products that I'd never use under any circumstance.

One of them is  CRM = salesforce.com

Our company ran a test with this a few years ago and it was the most hated product I had ever encountered. There were a myriad of glitches and support was poor. We ditched it after the 90 day evaluation.

I looked at CRM and found they have had a huge bull run this year.

VALUATION MEASURES   
Market Cap (intraday): 3.62B
Enterprise Value (28-Dec-05)3: 3.49B
Trailing P/E (ttm, intraday): 150.50
Forward P/E (fye 31-Jan-07) 1: 145.26
PEG Ratio (5 yr expected): 3.27
Price/Sales (ttm): 12.91
Price/Book (mrq): 19.31
Enterprise Value/Revenue (ttm)3: 12.77
Enterprise Value/EBITDA (ttm)3: 153.164

What has propelled this astronomical valuation?

Income Statement
Revenue (ttm): 237.07M
Revenue Per Share (ttm): 2.271
Qtrly Revenue Growth (yoy): 77.30%
Gross Profit (ttm): 142.92M
EBITDA (ttm): 17.48M
Net Income Avl to Common (ttm): 15.16M
Diluted EPS (ttm): 0.13
Qtrly Earnings Growth (yoy): 330.80%

Several Blow out quarters

So why consider shorting a stock with this much growth momentum?

Several factors:

1. Many companies are moving Contact Relationship Management in house as part of their Enterprise management software. (It used to be done with individual programs like Goldmine, Act or Maximizer)

2. Pressure on companies to lower SGA expensesof which CRM falls onto budget (at least in mine)

3. A valuation that surpasses Oracle, SAP and Google

4. Salesforce.com insider sales of 3.5 Million shares in the last 3 months

5. Negative Publicity - recent technical support problems including a power outage and a recently dismissed lawsuit

6. 3 analyst downgrades this month:

19-Dec-05 UBS Downgrade Neutral Reduce
16-Dec-05 Banc of America Sec Initiated   Neutral
12-Dec-05 Susquehanna Financial Downgrade Neutral Negative
12-Dec-05 Jefferies & Co Downgrade Buy Hold
2-Dec-05 Prudential Downgrade Overweight Neutral

So that's the case for shorting CRM, along with the break of the mid October trendline.

Thoughts?

David
I'd like to ask you a technical question which I think we need to know if we are to follow you on a short sale. As you know when you enter an order to short a stock your brokerage firm must be able to borrow it. This can only be confirmed at the exact time of the order. So, let's say you put out a short recommendation in the news letter, then enter your order and find you can't borrow the stock. Will you immediately notify us that you were unable or will you immediately purchase a put? Just wondering because There have been numerous occasions when I have shorted a stock and tried to add to that position and was unable to borrow additional stock even in a 10 minute time frame. Also, I am still of the opinion that the short portfolio should be  separate. I think we'll find members unable to borrow the stock and that means all positions are not available. I think this would actually create a great view of the  long portfolio and the short portfolio with each reflecting the origins of a total performance number

 

QuoteI'll use that cash to sell stocks short and buy puts (probably no more than 1% of capital in each position).

David,

I have to admit I don't know anything about options but I understand that occasionally we going to buy puts. If that's the case it means I have to activate that service with my broker ?


BTW here are the the steps to do that with Scottrade, in case someone is interested: 
----------------------------------------------------------------------------------------------

OPTIONS APPLICATION

Please complete the following steps:

Download form    (Get Acrobat Reader to view PDF forms)

Open a new account with Options Trading
Add Options Trading to an existing account

• Download PDF form
• Complete the Options Application Form
• All account holders must sign the application
• Mail the application to your local Scottrade office

   

** Scottrade policy allows clients approved for Options to complete the following transactions:

Sell Covered Calls
Buy Calls
Buy Puts

**Scottrade does not allow put selling or naked options.

------------------------------------------------------------------------------------------------

Thanks

My thoughts as well.  Take REDF for example, I have been trying to short that for 3 days now and I couldn't borrow shares.  I just can't believe every share of REDF is already shorted.  I think the MM knows it is going down and doesn't want anyone else to short it.  I know execution wise this "game" is rigged but this is ridiculous.  Maybe I just need to change brokers.  I'm using E*Trade Complete and it took them over 15 min to fill my order for GIGM last Friday and I see a lot of transactions going through before I got a fill and my limit price was two tiers above the best bid.

netfishmademe
The marketmakers have nothing to do with your ability to borrow the stock. The brokerage firm must be able to borrow it from an existing long . It's called hypothecation and you allow the brokerage firm to hypothecate your stock when you sign you account agreement form. This of course can only happen when you allow the firm to hold your stock. Hope this helps you better understand why there will be times that your firm won't be able to borrow the stock.

I talked to my Scottrade broker and he indicated if I can't get the shares online to call and they would call other brokerage houses to get the shares.

He said all of them come out of someone else's margin accounts.

KCScott
That is exactlly what is done. However, stock can be borrowed from any street name account, cash or margin, i believe. The point is the Market Makers have nothing to do with this. Now when you're talking about naked shorts you're going to find out that almost all naked shorts are the market makers. Firms won't let a retail account fail to deliver they'll just buy us in. It's the market makers who really stretch these rules.

Hi David,

Market breadth has improved markedly ( these last two days ).  New accumulation in many stocks is ocurring now!  The markets are poised for significant breakouts!!!!

Shorts will likely be slaughtered!  It pays NOT to be short at times like this in the markets!

willey